With all the foreclosure talk and the reasons behind it, it may come as a surprise to some that 100% financing still is alive and well. While conventional lenders have abolished straight 100% financing, the Federal Housing Administration (FHA) loan has again become the favorite loan program for home buyers everywhere. 

Long the last choice of borrowers, FHA financing has gotten hugely popular due to the continued availability of 97% financing (allowing purchasers to bring just 3% of their own money.) Borrowers will have to pay PMI, but most people gladly accept these terms in return for the reduced amount of money required.

Of course, even a 3% down payment may be a stretch for some wanting to live the American dream of home ownership. Hence, demand dictated that the market would try to find a way to cater to such borrowers. The solution was the Downpayment Assistance Program (DAP).

So, how does DAP work? It starts with a purchaser with no money finding a seller willing to give 3% or 6% (amounts allowed vary) of the home sales price as a donation to a non-profit DAP company. The DAP company in turn gives an equivalent amount of their "existing and different funds'" as a gift to the borrower. FHA allows gift funds as long as they are not from the seller, so going through a 3^rd party non-profit organization as described above was found to be a legal way around the current rules (info here.)

About 40 percent of the monthly FHA loan origination volume utilizes DAP these days...

So, what is the problem with this you may ask? (It has after all been found to be legal.) Even though you may not have heard of Ameridream, Nehemiah and others, they have all contributed to almost bring the whole FHA mortgage insurance program to its knees. According to HUD, FHA loans purchased with the help of DAP programs are 3 times as likely to default as for a traditional FHA loan (where the purchasers have put 3% into the property.) Allowing DAPs to continue would require a raise in the overall insurance rate for all loans and/or a federal subsidy according to HUD.

Not wanting the FHA program to go away, the mortgage rules will change effective October 1, 2008. President Bush signed H.R. 3221 Housing and Economic Recovery Act of 2008 into law on July 30, 2008. Included in this bill was the elimination of DAPs. The bill also increased the minimum amount of money a purchaser would need for FHA loans to 3.5%.

As an aside, downpayment assistance is not going away totally. Purchasers will still be allowed to receive gifts for the full 3% downpayment from 3^rd parties which includes family members and government entities like local city, county and the state. Apparently, the default rate on those is almost as high as those where the funds come indirectly to the seller.

Personally, being a Realtor working a lot with sellers, the new law will affect some of my own clients. In many neighborhoods, down payment assistance has been a part of a large portion of the offers received over the last year. The DAPs have allowed "regular" people to buy in at the bottom of the marked despite the stricter lending standards. It has also allowed my sellers to trade up into more expensive homes. As a consequence of DAPs going away, I do expect the market to slow on the lower end and for the slowdown to ripple up towards the higher price ranges.

However, in the long term requiring borrowers to bring at least some money (lets face it, 3.5% is still a low amount to bring in historic terms) should reduce the number of foreclosures and help strengthen the real estate market overall.

Some Realtors are vocal and unhappy with the changes. That is understandable as Realtors that  specialize in helping cash-strapped first time homebuyers will find it harder to help their clients purchase a home. That may not be a bad thing - renting may be the prudent thing to do until a down payment can be saved.

One of the reasons we got into the current foreclosure mess was that purchasers with no or little financial discipline were allowed to purchase homes they could not reasonably be expected to afford. The housing market will recover and will be stronger - coming up with 3.5% of the purchase price doesn't seem to be too big of a minimum requirement.

Using tax payers money to shore up the program so people can buy a home with no stake in it (and just walk away when times get tough) does a disservice to responsible homeowners everywhere.

If a private bank or private investor wants to take the risk of providing 100% financing, be my guest. Just don't turn around and try to sell it off as AAA+ rated securities again...